Lenders “securitize” mortgages when they package them up for the purpose of selling them to investors.
Securitization lets lenders raise new capital that they can lend to other borrowers.
Here is a basic overview of one of the most widely used forms of securitization in Canada, the Canada Mortgage Bond (CMB):
- Lenders originate mortgages
- Lenders arrange these mortgages into groups (pools)
- Lenders sell these pools as mortgage-backed securities (MBS) to the Canadian Housing Trust (CHT), a CMHC-run entity
- The CHT sells Canada Mortgage Bonds to generate funds to buy lenders’ mortgages
- The CHT uses the MBS cash flows to make interest payments on these CMBs to investors.
…and the process repeats itself over and over.
The mechanism above lets investors make secure investments in Canadian residential mortgages by buying CMBs.
Because CMBs are fully guaranteed by the government, investors demand less interest on CMBs. That lowers the cost of funds for lenders, which in turn lowers interest rates for homeowners.